1. Income Elasticity of Demand
DP Economics

2. Key Issues The meaning of income elasticity of demand
Measuring income elasticity
Normal goods
Luxury goods
Inferior Goods
Income elasticity of demand and the economic cycle

3. Income Elasticity of Demand
Income elasticity of demand (YED) measures the responsiveness of quantity demanded to changes in real income.
YED = %Δ demand / %Δ in income
Example:
A rise in consumer real income of 7% leads to an 9.5% rise in demand for pizza deliveries.
The income elasticity of demand:
= 9.5/ 7 = +1.36

4. Income elasticity coefficient Classification of good
Effect
Income elasticity coefficient
Classification of good
A proportionately larger change in the quantity demanded
>1
Luxury good
A proportionately smaller change in the quantity demanded
<1
Normal
A negative change in the quantity demanded
<0
Inferior good

5. Inferior Goods
Inferior goods have a negative income elasticity of demand. Demand falls as income rises
For example:
A 12% rise in incomes leads to a 3% decrease in the demand for bus travel
The income elasticity of demand = -3/+12
Yed = -0.25

6. Different Types of Goods and their Income Elasticity
Luxury
Normal Necessity
Inferior Good
Air travel
Fresh vegetables
Frozen vegetables
Fine wines
Instant coffee
Cheep Cigarettes
Luxury chocolates
Natural cheese
Processed cheese
Private education
Fruit juice
Margarine
Private health care
Spending on utilities
Tinned meat
Antique furniture
Shampoo / toothpaste / detergents
Value “own-brand” bread
Designer clothes
Rail travel
Bus travel

7. Income Elasticity of Demand for Chocolate
Total consumption
USA +0.79
Germany +0.39
United Kingdom +0.44
France +0.60
Japan +0.1
Switzerland +1.06
Reference: Henri Jason Trends in cocoa and chocolate consumption with particular reference to developments in the major markets. Malaysian International Cocoa Conference, Kuala Lumpur, October 1994 (ICCO, ED(MEM) 686)

8. Income Elasticity and the Demand for Airline Travel
Demand for air travel has a positive income elasticity of demand
The industry is cyclical
During an upturn, demand rises for business and leisure travel
During a recession, the demand tails away
In the long run, there is a positive relationship between real GDP per capita and the demand for air travel
Income elasticity will vary according to the type of air travel
E.g. difference between low-cost “no-frills” and higher priced scheduled services on low-haul flights

9. Income Per Capita and Airline Travel by Country

10. Significance of Income Elasticity of Demand
High Income Elasticity
Demand is sensitive to changes in real incomes
Demand is therefore cyclical – in an economic expansion, demand will grow strongly. In a recession demand may fall
Can be difficult for businesses to accurately forecast demand and make capital investment decisions

11. Significance of Income Elasticity of Demand
Low Income Elasticity
Demand is more stable during fluctuations in the economic cycle than high YED
Over time, the share of consumer spending on inferior goods and normal necessities tends to decline
Long run – businesses need to invest in / focus on products with a higher income elasticity of demand if they want to increase total profits